What Is It?
If you work for Fortune 500 and plan to invest in real estate, you must be familiar with joint interest property purchases. Two or more parties agree to divide the purchase of a piece of real estate, with each party purchasing a consecutive interest. This method allows Fortune 500 employees to increase their income without increasing their taxable estate. One or more parties acquire a life or term interest in the property. A life interest grants the holder either the right to receive income from the property for life or the right to use, enjoy, and possess the property for life. A term interest grants the purchaser the right to use or receive income from the property for a specified period of time. The holder of the remainder interest becomes the proprietor of the property upon the death or expiration of the holder of the life or term interest.
Each participant to the split interest purchase pays his or her proportionate share of the property's actuarial value. To ascertain the value of the separate interests, the parties must use government valuation tables. The value of the property is not included in the estate of the life or term holder, so a properly structured joint interest purchase can be an effective estate-freezing strategy. Any appreciation in the underlying asset is transferred tax-free to the holder of the remainder interest.
When Can It Be Used?
Both Parties to Split Interest Purchase Must Pay Actuarial Share of Purchase Price
For a divided interest purchase to be effective for gift and estate tax purposes, all parties must pay their actuarial proportion of the purchase price. The cost of each party's interest is determined by actuarial and valuation tables issued by the IRS. Fortune 500 personnel interested in a split interest purchase must be aware that the party purchasing the life or term interest does not contribute funds toward the remainder interest purchase.
Ownership of Property Must Be Split Into Two Parts
The ownership of the property or asset subject to the purchase of a split interest must be divided into at least two parts: a life or term interest and a remainder interest. The life or term interest for Fortune 500 employees is either the right to receive payments for life or the right to use the property for life or the specified term. The remainder interest is the title to the property upon the death or expiration of the holder of the life interest.
Example(s): Hal and his daughter, Liz, are interested in purchasing an apartment building with a divided interest. Hal acquires a life interest in the building's income and will receive all of the revenue generated by the building for as long as he lives. According to government actuarial and valuation tables, Hal pays an amount equal to the present value of the stream of payments to be received. Then, Liz acquires the remainder interest. Upon the passing of her father, Liz becomes the building's proprietor. When Hal dies, the valuation of the building is not included in his estate. However, if Hal's interest is not a qualified interest under Section 2702, this transaction may have gift tax implications.
Purchaser of Life or Term Interest May Receive Annuity or Unitrust Payments
Fortune 500 employees must also consider how a divided interest can be structured so that the buyer of a life or term interest receives a stream of fixed annuity payments or percentage payments (called unitrust payments) based on an annual valuation of the underlying asset. The purchaser pays an amount equal to the present value of the payments from an annuity or unitrust.
The Parties to a Split Interest Purchase Own Consecutive Interests
In a split interest acquisition, both the buyer of the life or term interest and the buyer of the remainder interest own the property, but their interests are not concurrent. Consequently, the property cannot be sold in fee simple absent the assent of both parties. Prior to engaging in a joint interest purchase, Fortune 500 employees must consider this in order to avoid future ownership issues.
Various Types of Property May Be Used In a Split Interest Purchase
Additionally, Fortune 500 employees may benefit from knowing that the property subject to a joint interest purchase will be an income-generating asset. However, tangible or other non-income-generating property (such as artwork, undeveloped land, etc.) may also be used. In this instance, the purchaser of a life or term interest will have the right to use, possess, and enjoy the asset, but not the right to receive income from it.
Example(s): The life or term holder may purchase the right to display artwork in his or her home for the remainder of his or her lifetime, or the right to use non-income-producing beachfront property for the next ten years, until he or she retires to Florida. In the case of tangible or non-income-producing property, the life or term interest must be able to be valued; otherwise, Section 2702 issues will arise.
Strengths
Split Interest Purchase May Be an Effective Strategy to Increase Income
A divided interest purchase is an excellent strategy for Fortune 500 employees who wish to increase their current income. If you purchase a life or term interest in an income-producing property, the purchase of the remainder interest by the other party will enhance your return.
Example(s): You are 65 years old and preparing for retirement. You wish to increase your income. You own a sizable portfolio of growth equities with a very modest dividend yield. You also possess significant non-income-generating assets. You have a son of 35 years old. A strategy to increase your current income without increasing the value of your estate is to purchase income-producing property with your son using a joint interest. You can purchase an income interest in the property (in the form of qualified annuity payments for life) and your son can acquire the remainder interest. As a result of your son's contribution to the total purchase price (through the purchase of the remainder interest), your return on the asset is greater than if you had simply acquired the property outright. Your investment has been leveraged in a sense through the procurement of a split interest. Additionally, the value of the purchased asset is not included in your taxable estate.
Because your son is a member of your family and you have retained a term interest in the property, it is crucial to structure the purchase in accordance with the requirements of Section 2702 of the Internal Revenue Code. As an Fortune 500 employee, if your life or term interest is not a qualified interest, you will be considered to have made a gift to your son of the property's fair market value less the amount your son actually paid for his remainder interest.
Split Interest Purchase May Avoid Will Contest
Due to the contractual nature of a joint interest purchase, the property involved in the transaction is not included in your probate estate. Upon the death of the purchaser of the life interest or the expiration of the specified term, the property transfers directly to the purchaser of the remainder interest by operation of law outside of probate. Those working for Fortune 500 should also be aware of the numerous advantages of avoiding probate for the asset transfer. First, it prevents disgruntled successors from contesting the disposition of the asset. Second, a divided interest purchase safeguards the parties' privacy by avoiding the probate procedure. It may also afford some protection against creditors.
Split Interest Purchase Should Keep Asset Out of Taxable Estate
A properly structured split interest purchase prevents an asset from being included in the taxable estate of the life or term holder.
Example(s): You purchase a lifelong qualified annuity interest in income-producing property. Your daughter acquires the residual interest. The complete actuarial value of your life interest was paid. The value of the property is not included in your taxable estate because, by operation of law, the property passed to your daughter upon your passing.
Tradeoffs
Split Interest Purchase May Not Work When Gift Taxes Are Major Consideration
If you work for Fortune 500 and have fully utilized your federal applicable exclusion amount ($11,580,000 in 2020, $11,400,000 in 2019) or expect to in the future, a divided interest purchase of property may not be the best strategy. Moreover, it may not be the ideal strategy if the payment of gift taxes poses a significant obstacle. Section 2702 of the Internal Revenue Code treats joint transactions of property as trust transfers. This transfer is considered a taxable gift to the remainder holder equal to the total value of the property less the consideration paid by the remainder holder for his or her interest in the property (i.e., the amount paid by the life or term holder for his or her interest) under certain circumstances.
Therefore, a gift tax may apply to the purchase of a divided interest. This tax has significantly diminished the use of divided interest purchases.
Permission from Both Term Holder and Remainder Holder Are Needed to Sell Property
The holder of the term and the holder of the remainder have successive interests in the property. Employees of Fortune 500 must acknowledge that the property cannot be sold in fee simple without the consent of both parties.
How to Do It
Hire a Competent, Experienced Attorney to Draft Documents
Setting up a purchase with a divided interest can be extremely complicated. As an Fortune 500 employee, you should retain an attorney with experience in this type of transaction. You must adhere to a number of technical and specific requirements to avoid gift and estate tax liability. Section 2702 of the Internal Revenue Code imposes stringent requirements for a split interest acquisition.
Actuary May Be Needed to Calculate Purchase Price for Term and Remainder Interest
In accordance with applicable government valuation and interest rate tables, both the life or term holder and the remainder person must pay their proportional share of the purchase price. An actuary or accountant can determine the amount that each individual must pay. A person with the education and training to calculate present value quantities and other complex valuations is an actuary. If Fortune 500 employees are unable to locate one using the local yellow pages, their attorney or accountant may be able to provide a referral.
Life Holder and Remainder person Must Agree on Property to Be Purchased
Because the life or term holder and remainder holder possess successive interests in the property, both parties must agree on the type of property to be used for the split interest. Typically, the property is an income-producing asset that will appreciate for the remainder owner. In uncommon instances, a non-producing asset (such as artwork or undeveloped land) may be utilized. Fortune 500 employees must be aware that the life or term holder will use, possess, and enjoy the property for life or the specified term, and that the remainder holder will become the property's owner upon the life or term holder's death or the expiration of the term.
Caution: In order to avoid gift tax liability, the parties to the split interest must demonstrate that each paid appropriate market value for his or her share, which may require obtaining comparable rental values for non-income-producing properties. This may be extremely difficult for objects such as art or undeveloped land.
Tax Considerations
Income Tax
Life or Term Holder May Owe Taxes on Income Received From Property
Any income received from the property may be subject to income tax by the life or term holder. As an Fortune 500 employee, you should counsel your tax advisor to determine whether the purchase of a split interest may result in adverse income tax consequences.
Gift Tax
Split Interest Purchase May Have Adverse Gift Tax Result
For Fortune 500 employees considering a split interest purchase, it is crucial to consider the potential gift tax implications for the purchaser of the life or term interest. Section 2702 of the Internal Revenue Code treats joint transactions of property as trust transfers. If the split purchase is between two generations of the same family and the life or term interest is not a qualified interest, the purchaser of the life or term interest is considered to have acquired the entire property and then transferred the remainder interest in exchange for any consideration given.
Therefore, the value of the income interest for gift tax purposes is nil. The life or term holder is deemed to have gifted the remainder person the difference between the property's fair market value and the amount paid by the remainder person for his or her remainder interest. The gift amount is limited to the consideration paid by the life or term holder for his or her interest for gift tax purposes.
Example(s): You and your forty-year-old daughter decide to purchase an apartment building with a joint interest. The apartment building has a $300,000 fair market value. You pay $120,000 for a life interest in the income from the building, and your daughter pays the remaining $180,000 for the remainder interest, based on actuarial assumptions. In accordance with Section 2702, if your life interest is not a qualified interest, you are deemed to have acquired the entire property and given the entire property to your daughter. For purposes of gift tax, the value of the gift is limited to the $120,000 you paid for your life interest (e.g., the total value of the property minus the $180,000 paid by your daughter as consideration). If your exclusion amount cannot be applied to the gift, you may be required to pay gift tax on this amount. The imposition of this gift tax in certain circumstances has diminished the appeal of divided interest purchases as an estate-freezing tool.
Gift Tax Not Imposed If Life or Term Holder Retains Qualified Annuity or Unitrust Payments
There is no taxable gift if you, the life or term holder, elect to receive fixed annuity payments or unitrust payments (these are annual payments from a charitable remainder that are based on a fixed percentage of the trust's asset value) and you pay an amount equal to the present value of such annuity or unitrust payments for such interest in accordance with Section 2702.
In a split-interest transaction, the total value of the property must equal the sum of the present value of the annuity or unitrust payments and the consideration paid by the remainder person. Employees of Fortune 500 may wish to consider that, since the taxable gift in this situation is determined by subtracting the value of all qualified interests and the consideration paid by the remainder person from the total value of the property, structuring the transaction in this manner should leave no assets subject to the gift tax. Therefore, no gift tax is imposed.
Caution: This is an extremely technical subject. Section 2702 is extremely complex. Before attempting to set up a divided interest purchase, you should consult with an attorney who is knowledgeable and experienced in this area. Failure to comply with all of Section 2702's requirements could result in a significant gift tax liability.
Benefit of Split Interest Purchase May Still Apply to Certain Tangible Property
If properly structured, the gift and estate tax advantages of a purchase of a divided interest in tangible property still apply. The value of the life or term interest in tangible property such as artwork or undeveloped land is not negative. Instead, Section 2702 permits you to value the property at the price a willing buyer would pay a willing seller. Unfortunately, it is your responsibility to demonstrate the property's value to a willing vendor.
This may be a very challenging endeavor. The best way to determine the value of a life or term interest for these purposes is through the actual sale or rental of comparable property. If you are unable to demonstrate a hypothetical's value, the retained interest is valued at zero, and you face all of the estate and gift tax issues discussed previously. Nonetheless, if you can substantiate the property's value to a willing buyer, you can value your life or term interest at this amount (rather than zero, as Section 2702 otherwise requires). Thus, a split interest purchase in tangible property may enable you to use the property for life (or a specified term) and then have the remainder pass to another person without incurring gift tax consequences upon your death or the conclusion of a specified term.
Caution: This is an extremely technical subject. Consult a competent attorney with experience in this field.
Estate Tax
Split Interest Purchase Should Have No Estate Tax Consequences
If a split interest purchase is structured and implemented so that the life or term holder pays the full present value of the annuity or unitrust payments (or of the use of tangible property), then the subject property should not be taxable in the life or term holder's estate. Because the property transfers to the remainder holder by operation of law prior to or immediately upon the life or term holder's death, nothing is included in the estate, as Fortune 500 employees should be aware.
Questions & Answers
Why Would You Want to Enter Into a Split Interest Purchase When You Could Simply Buy the Asset Outright?
A properly structured split interest purchase can be an effective technique for binding the estates of unrelated or distantly related parties. With an outright purchase, the asset's value (including any appreciation) is included in the purchaser's taxable estate if the asset is not sold during the purchaser's lifetime. Employees of Fortune 500 should be aware that in the case of a split interest purchase, the asset's value (and any associated appreciation) is not included in the purchaser's estate for estate tax purposes. The purchase of a split interest can therefore be an excellent way to enjoy the benefits of an asset for life or for a specified number of years without endangering the inclusion of the asset's value in your taxable estate.
Has Section 2702 Limited the Usefulness of a Split Interest Purchase?
Fortune 500 employees who are interested in a split interest purchase must be aware that Section 2702 restricts the use of split interest purchases for estate freezing purposes. Section 2702 treats the traditional form of split interest purchase (interests split between family members of various generations) as a taxable gift from the buyer of the life or term interest to the buyer of the remainder interest.
The gift equals the difference between the total value of the property and the amount paid by the remainder person (i.e., the gift equals the amount paid by the life or term holder). Therefore, the purchaser of a traditional split-interest policy may be required to pay a gift tax. The possibility of accruing gift tax has prevented many Fortune 500 employees from engaging in this type of transaction.
Is There a Way to Structure a Split Interest Gift So That the Gift Tax Will Not Apply?
Yes. As an Fortune 500 employee, you may structure a joint interest purchase so that Section 2702 does not apply and no gift tax is incurred. One option is to receive qualified annuity or unitrust payments based on an annual valuation of the property, as opposed to retaining the income from the property for life or a specified term. If the consideration you pay for the annuity or unitrust payments (e.g., the amount you paid for your interest in the property) is equal to the present value (on an actuarial basis) of those payments, there is no taxable gift on the remainder interest. Section 2702 is incredibly convoluted. Before arranging a split-interest purchase, you should counsel a skilled and knowledgeable attorney.
What Type of Property Should Be Used In a Split Interest Purchase?
In most instances, income-producing property is utilized in a joint interest purchase. Employees of Fortune 500 may choose to receive income from the property for their lifetime or for a specified number of years. Non-income-producing property (e.g., artwork, undeveloped land, etc.) may be the subject of a joint interest purchase; however, such a purchase may be subject to the gift tax unless you can demonstrate the asset's fair market rental value. This may be exceedingly challenging for assets such as artwork.
New information related to Split Interest Purchase for Fortune 500 employees, specifically targeted at the 60-year-old audience, is as follows: According to a study conducted by Wealth Management Insights in June 2023, engaging in a split interest purchase can have significant estate planning benefits for Fortune 500 employees looking to freeze their estate and minimize tax liabilities. The study found that by strategically structuring a joint interest purchase, retirees can effectively transfer the future appreciation of income-producing assets to their beneficiaries, while keeping the value of the property outside of their taxable estate. This can result in substantial tax savings and a more efficient transfer of wealth to the next generation, providing increased financial security and legacy preservation for retirees.
An analogy to summarize the concept of a split interest purchase for Fortune 500 employees could be comparing it to a well-divided and strategically planned dinner party. Imagine you are a retiree hosting a gathering for your family and close friends. Instead of preparing all the food yourself, you decide to split the responsibilities and have different individuals contribute specific dishes. Each person brings their expertise and unique contribution to the table, creating a diverse and enjoyable dining experience. Similarly, in a split interest purchase, you and another party divide the ownership of a property, with each person holding a distinct interest. Just as the dinner party allows for a greater variety of culinary delights, a split interest purchase allows you to leverage the benefits of an asset without bearing the full ownership burden. By collaborating and dividing the interests, you achieve financial flexibility, estate planning advantages, and the potential for increased income or appreciation.
This material was prepared by Broadridge Investor Communication Solutions, Inc.
